FORIEGN ACCOUNT TAX COMPLIANCE ACT (FATCA) : THE ULTIMATE ANTI-MONEY LAUNDERING WEAPON

I. OVERVIEW

FATCA, it colloquially refers to Chapter 4 of the US Internal Revenue Code, which was enacted by the US legislature as part of the Hiring Incentives to Restore Employment ("HIRE") Act on March 18,2010. The regulations for FATCA have undergone revision since 2010 and the final regulations make the FATCA provisions effective from July 01, 2014.

The Act is essentially a measure aimed at identifying those US persons who may be evading tax through the use of offshore investment vehicles and to gather information on them that ensures the US Internal Revenue Services ("IRS") can collect the appropriate amount of tax from all US persons. US congress estimates that tax evasion by US persons equates to losses for the US Treasury of up to $100 billion annually.

To achieve this goal, FATCA requires Foreign Financial Institutions ("FFIs")and Non-Financial Foreign Entities ("NFFEs") to identify and disclose their US account holders and members or become subject to a new 30% U.S. withholding tax ("Withholdable Payments") on any payment of US source investment income such as interest, dividends, rents, salaries ("FDAP Income") and gross proceeds from the sale or disposition of US stocks and securities.

The overall purpose is to detect, deter and discourage offshore tax abuses through increased transparency, enhanced reporting and strong sanctions.

FATCA also contains other provisions related to US tax compliance that directly impact US taxpayers, which are not discussed herein.

II. MECHANISM & COMPONENTS

Firstly, FATCA requires FFIs to provide documentation on their US account holders to IRS. If they choose to do so, they are "Participating FFIs"and the FFIs who do not provide documentation to the IRS are "Non-participating FFIs".

Equally, FATCA requires the Account Holders to provide information to Participating FFIs to establish their status as "US or non-US entities". If they fail to do so they are labeled "Recalcitrant Account Holders"and there are certain indicators (�US Indicia�) to determine that an account may be a "US Account"or held by a "US Person".

FATCA also requires US payers or "Withholding Agents"to withhold a 30% tax on payments to Non-Participating FFIs or NFFEs. These payments are called "Withholdable Payments".

On the other hand as an incentive to the Participating FFIs, FATCA authorizes them to withhold 30% on payments that fall within the definition of Withholdable Paymentswhen made to Non-Participating FFIs or NFFEs and Recalcitrant Account Holders. These payments are called "Foreign Passthru Payments".

Therefore, under FATCA, FFIs wear two hats with distinct responsibilities - as the payor(Withholding Agent) of WithholdablePayments and as the payee (recipient) of WithholdablePayments.

How FATCA Works

FFI :

The definition of an FFI is very broad and is expected to encompass a number of entities generally not considered to be Financial Institutions (FIs). An FFI is any foreign entity that:

a. accepts deposits in the ordinary course of a banking or similar business. - �Depository Institution�.
b. holds, as a substantial portion of its business, financial assets for the account of others. - �Custodial Institution�.
c. engaged (or holding itself out as being engaged) primarily in the business of investing, reinvesting, or trading in securities, partnership interests, commodities, or any interest (including a futures or forward contract or option) in such securities, partnership interests, or commodities. - �Investment Entity�.
d. is an insurance company (or the holding company of an insurance company) that issues, or is obligated to make payments with respect to, a cash value insurance contract or an annuity contract. - �Specified Insurance Company�.

Thus, it should be noted that all structures by which investments are made into India from the US such as investment funds, professional fund manager entities, banks, wealth planning trusts, foundation structures, e.t.c. would typically constitute FFIs owing to the large scope of this definition.

Entities that would be excluded from the definition of FFI :

In Notice 2010-60 & Notice 2011-34 US Treasury and the IRS identified certain types of entities as excluded from the definition of an FFI or known as �Deemed Compliant�.

Such entities include:

• Certain holding companies for subsidiaries engaged in a non financial business;
• Non-Financial �start-up� entities (exclusion valid for first 24 months of organization);
• Non-financial entities that are liquidating or emerging from reorganization or bankruptcy;
• Hedging/financing centers of a non-financial group (must provide financing services solely to  members of its expanded affiliated group);
• Insurance companies selling insurance products without cash value;
• Entities with certain identified owners;
• Certain financial institutions organized in US Territories
• Local banks that do not solicit account holders outside their country of organization and implement procedures to ensure that they do not open or maintain accounts for non residents, Non-Participating FFIs or non-excepted NFFEs;
• Local FFI members of Participating FFI Groups; and
• Certain investment vehicles that only have participating FFIs as direct interest holders and certify that any PassthruPayment percentages are calculated and published in accordance with Notice 2011-34.

However, to obtain a Deemed Compliant status, eligible FFIs must apply to the IRS, obtain an FFI Identification Number (FFI-EIN) and certify every three years to the IRS that it meets the requirements for such treatment.

NFFEs :

An NFFE is any foreign entity that does not meet the definition of an FFI. It generally includes any foreign entity that is not engaged in the banking or investment management business. Accordingly, NFFEs include all foreign entities that are not FFIs in which there is a US substantial ownership i.e., a Specified US Person that owns more than 10% of the foreign entity.

Certain NFFEs are excepted from FATCA and thus are �Excepted NFFEs.� Excepted NFFEs in this regard include:

• Publicly traded corporations and affiliates (more than 50% ownership).
• Territory NFFEs that are directly or indirectly wholly owned by bona fide US territory residents in the NFFE's country of organisation.
• Active NFFEs � entities that conduct an actual business activity other than holding assets that produce investment income such as interest, dividends, rents, etc.

Indicators to determine whether an account is a US account or held by a US person - �US Indicia�:

• Identification of the account holder as a US resident or citizen;
• Unambiguous indication of a US place of birth;
• Current US resident address or US mailing address (including a US post office box);
• Current US telephone number;
• Standing instructions to transfer funds to an account maintained in USA;
• Current effective Power of attorney or signatory authority granted to a person with a US address; or
• An �in-care-of� address or �hold mail� address in USA that is the sole address the Indian Financial Institution has on the file for the Account holder.

III. COMPLIANCES UNDER FATCA

FATCA provides for FFIs in India to register with the US IRS, obtain a Global Intermediary Identification Number (GIIN) and enter into an agreement (�FFI Agreement�) with US IRS to report US accounts.

Alternatively, to avoid entering into an agreement and direct reporting by individual FFIs to the US IRS, there is a provision for Inter-Governmental Agreement (IGA) between a Partner Government and US Government.

The US Treasury had released two formats of the IGA - Model 1 and Model 2.

Under Model 1 IGA the FFIs will report information on certain account holders to their national tax authorities, which in turn will provide such information to the United States under an automatic exchange of information. In Model 2, FFIs will report information directly to the US IRS rather than their local jurisdictions.

Government of India (GoI), has advised that India and US have reached an agreement 'in substance' on the terms of an IGA � Model 1 to implement FATCA and India is now treated as having an IGA 'in effect' from April 11, 2014. However, the IGA may be signed in due course.

The US IRS website has also reported that the jurisdictions that have reached agreements 'in substance' with the United States on the terms of IGAs can be treated as having agreements 'in effect' until the end of 2014 and India has consented to disclose this status. So we are mainly focused on Model 1 IGA and its impact.

The IGA arrangement provide for all FFIs that resident in / organized in the jurisdiction of India to identify US accounts and report through the Indian government to US IRS.

The major provisions of the Model I IGA that deviate from the proposed FATCA regulations are as follows :

1. FFI Agreement

FFIs in India would be required to report all FATCA related information to Indian governmental agencies, which would then report these information to US IRS. Some Model 1 IGAs have also provision for reciprocity, requiring the US to provide certain information about residents of the Model 1 country to the Model 1 country in exchange for the information that country provides to the US. Since India has entered into an agreement under Model 1, Indian FIs do not need to sign an FFI Agreement but register directly with the IRS. Information is delivered through Central Board of Direct Tax (�CBDT�).

2. Modified withholding obligations

The Model 1 IGAs do not require signatory country FIs to withhold on gross proceeds or Passthru Payments to (and close the accounts of) Recalcitrant Account Holders that fail to provide the required information to the FIs. Instead, penalties may be imposed on FIs that fail to comply.

3. Deemed Compliant

Indian FIs are automatically deemed compliant and will not be subject to US Withholding of 30% on US sourced payments as long as they fulfill their obligation.

4. Replace 10% test with Control test

In case of NFFEs, for compliance under an IGA, the substantial owner test would be the �controlling test�, entailing that the ownership threshold would be 25%, as opposed to 10% under FATCA.

5. All-or-none rule inapplicable

The Model 1 IGAs permit signatory country FIs to comply with FATCA even if their affiliates or branches outside of the signatory country are prohibited by local law from complying, provided that certain requirements are met. The proposed regulations followed an �all-or-none� rule (subject to temporary limited exceptions) in which, in general, all members of an affiliated group must comply with FATCA.

6. Removes domestic legal impediments to compliance by information sharing

An IGA would directly address legal impediments to implementation of FATCA such as data privacy laws, banking secrecy laws, e.t.c.

Till today USA has concluded Model 1 IGA with 34 countries including United Kingdom, Canada, France, Germany, Australia, Cayman Islands, Italy, Mauritius and Model 2 IGA with 5 countries Austria, Bermuda, Chile, Japan & Switzerland. Also, there are 54 jurisdictions that have reached agreements �in substance� with USA including India, China, Malaysia, Singapore, Thailand, UAE. The entire list can be seen at -

http://www.treasury.gov/resource-center/tax-policy/treaties/pages/fatca-archive.aspx.

RBI vide a circular, dated June 27, 2014 and SEBI vide a circular, dated June 30, 2014 issued few guidelines in this regard which are as follows -

• Indian FIs have time upto December 31, 2014 to register with US authorities and obtain a GIIN.
• Indian FIs having overseas branches in Model 1 jurisdictions (including 'in substance'IGA jurisdictions) have time upto December 31, 2014 to register with US authorities and obtain a GIIN.
• Overseas branches of Indian FIs in a jurisdiction having IGA Model 2 agreement or in a jurisdiction that does not have an IGA but permits FIs to register and agree to an FFI Agreement, may register with US authorities within the stipulated time period and obtain a GIIN, to avoid potential withholding under FATCA.
• Overseas branches of Indian FIs in jurisdiction that does not have a IGA and does not permit FIs to register and agree to an FFI Agreement may not register and their overseas branches would eventually be subject to withholding under FATCA.
• If registration of the parent bank/ head office is a pre-requisite for a branch to register, such banks may register as per the time line indicated at (b) and (c) above.

FATCA compliance timeline

The important dates for FATCA compliance are -

• Registration with US IRS till 31 December, 2014.
• In respect of all accounts Pre-existing as on 30 June, 2014, the identification for US Person is required to be done by 30 June, 2016 except for high value individual accounts, which needs to be done by 30 June, 2015.
• Identification and due diligence process for all new accounts opened on or after 1 July, 2014 can be done within one year from the date of entry into force of the IGA.

IV. CHALLENGES AHEAD

Regarded as one of the most controversial extra-territorial tax legislation, FATCA is likely to impact various types of FIs in India. As FATCA will require Indian FIs to submit detailed information on their US customers, there is significant pressure on the financial services sector to get their compliance and IT systems in place so that they can be FATCA Compliant.

The various implications of FATCA are as follows :

1. Reporting / Identification Implications -

FATCA will have wide implications on FFI with regard to the reporting requirements, which will require major changes in the system to generate the information as required by the IRS. For the FFI groups, this would involve identifying US accounts, complying with due diligence procedures and reporting annually for US account; providing any further information upon request, withholding on any Passthru Payments to Recalcitrant Account Holders or Non-Participating FFIs.

Financial Implications -

Because of FATCA Participating FFIs will need to invest in three key areas :

• Documentation: capturing process changes and analyzing the customer database.
• Withholding: building functionality for withholding on Recalcitrant Account Holders.
• Reporting: building and sustaining a reporting model for all US persons to cover account balances and gross payments

3. Technological Implications -

FFIs will be required to carry out major technological changes in their existing systems to comply with reporting requirement under FATCA. Numerous unrelated systems must be addressed and modified to enable new required information reporting and withholding.

4. Customer Implications -

There would be customer implications on account of sharing of sensitive information and the onus cast on the banks to close the customer's accounts in case they do not permit reporting of accounts in jurisdictions where confidentiality norms are applicable.

5. Awareness -

There is not a full awareness of FATCA, its requirements and the resulting impact to the businesses, which will necessitate early, senior-level commitment and communication. If employees fail to comply with FATCA, there could be penalties for the FFI.

V. CONCLUSION TO A BEGINNING

FATCA is not just another tax issue that affects aspects of compliance, rather, it touches the whole value chain and requires completely new and extended information and reporting systems. Therefore, FFIs need to put together a process to meet the FATCA implementation deadline and earlier the better.

However, IGA would be signed only after the approval of cabinet, it will be desirable if the entities initiate the process to sensitize their staff, dealing with NRI/PIO accounts to obtain -

• Full KYC details of passport number, country of citizenship/resident, tax identification numbers, contact details including full address, telephone numbers, email ids etc., while dealing with foreign nationals, business entities etc.
• Initiate the process of obtaining above details in respect of all pre-existing accounts using search for above US Indicia by making electronic and/or paper search of the database.
• Keep themselves updated of any further development in regard to FATCA.

Incidentally, G20 in their meeting held on September 06, 2013 endorsed an accord for exchange of information regarding the accounts opened by citizens of one member country in the other member country within the G20, to which India is also a signatory. A Common Reporting Standard on Automatic Exchange of Information was further endorsed by G20 Finance Ministers' in their February, 2014 meeting. It was also decided that to adopt rules for exchange of information by entering into Competent Authority Agreement (CAA) between the G20 member states. This arrangement is expected be made effective by 2015 and would be broadly in the lines of FATCA.

That�s why we say, it's just a beginning.